Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.

NetEase Shows Investors Its A-Game

The Chinese online gaming company is playing to win.

As important as the video game industry is in the U.S., it can be hard for investors to understand just how huge a market China provides to companies catering to online gamers. NetEase (NASDAQ:NTES) has done an exceptional job of giving Chinese gamers what they want, and shareholders have gotten used to the company's success in producing impressive financial results. Coming into Wednesday's second-quarter financial report, NetEase investors wanted to see continued evidence of strong growth, and NetEase gave them everything they could have asked for and more. Let's take a closer look at how NetEase did this quarter and whether it can sustain its fast growth pace in future quarters.

NetEase flips the machine with solid performance

NetEase's second-quarter results once again dramatically exceeded the high expectations that investors had from the online gaming specialist. Revenue nearly doubled in local-currency terms, hitting $1.35 billion, which was far greater than the $1.26 billion consensus forecast among those following the stock. Similarly, NetEase posted impressive bottom-line performance, with adjusted net income of $484.6 million reflecting a roughly 100% increase in earnings as measured in China's currency. Adjusted earnings per American depositary share of $3.70 more than doubled the year-ago figure and exceeded expectations by more than $1 per share.

Taking a closer look at online gaming specialist's numbers, the same trends that NetEase has seen in the past continued to appear in its financial results. Revenue from online game services climbed by more than three-quarters to $969 million, and sales generated by email, e-commerce, and other types of revenue more than quadrupled from year-ago levels to nearly $300 million. The advertising services sector posted more modest growth of about 25%, but it has become an insignificant source of revenue for NetEase over the years.

In addition, the margin compression that NetEase has suffered once again showed itself, but the pace of the declines has slowed considerably. Online gaming gross margin fell by about three percentage points to 66.2%, but gains in email-related gross margin figures offset the decline. Overall, NetEase saw gross margin fall to 59%, but a slower pace of growth in operating expenses helped to boost operating margin figures and produce impressive profit gains.

CEO William Ding was once again pleased with NetEase's results. The strong quarterly results "reflect NetEase's leadership in China's dynamic online games industry," Ding said, "where we continue to introduce premium game content, innovative technology, and effective marketing strategies." The CEO also pointed to the way in which NetEase is looking at embracing new technology to try to deliver the experiences that gamers want.

How NetEase sees the future getting even better

NetEase has captured a huge share of the growing mobile gaming market, with more than 100 titles that include several strong franchises. Many titles have become popular not just in China but also in South Korea, and NetEase has the potential to become much more of a regional powerhouse as it looks at its overall expansion strategy.

At the same time, NetEase isn't content with what it has achieved thus far. The company is also looking at virtual reality and similar new offerings to see how it can develop content that will lead NetEase forward in the future. Collaboration with the creator of the popular Minecraft game to develop a Chinese version of the program also has NetEase excited about its position in the market.

Investors have gotten used to seeing NetEase share its success in the form of higher dividends, and the company didn't disappoint this quarter. The income-tied payout rose to $0.78 per depositary share, up a nickel from the previous quarter.

NetEase shareholders seemed happy with the report, sending the stock up nearly 3% in after-hours trading following the announcement. With so much positive momentum, NetEase has the potential to keep setting new all-time record highs as long as the Chinese online gaming market remains as strong as it has been in recent years.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
Follow @DanCaplinger